States with Reciprocal Tax Agreements: Complete Guide

Understanding State Reciprocal Tax Agreements

If you work in one state but live in another, you may be wondering whether you need to file income tax returns in both states. The answer depends on whether those states have established reciprocal tax agreements. A reciprocal agreement is an arrangement between two or more states that allows residents of one state to work in another state without paying income taxes to the work state. Instead, employees only pay state income taxes to their home state (the state where they live), simplifying their tax filing requirements and potentially saving them money.

The concept of reciprocal agreements is rooted in constitutional law. According to the U.S. Supreme Court’s decision in the 2015 case Comptroller of the Treasury of Maryland v. Brian Wynne, it is both illegal and unconstitutional for two states to impose income taxes on the same income. The court determined that such double taxation violates the U.S. Constitution’s Commerce Clause by improperly punishing interstate commerce. This landmark decision underscores the importance of reciprocal agreements in protecting employees and employers from paying excessive taxes on the same earned income.

How Reciprocal Agreements Work

Under a reciprocal agreement, employees who work in one state but reside in another only pay income taxes and file a tax return in their home state. In their work state, they are exempt from paying income taxes and are not required to file a state income tax return. However, employees typically need to file an exemption form with their work state to claim this tax-exempt status.

For example, if you live in New Jersey and work in Pennsylvania—two states with a reciprocal agreement—you would only pay state income taxes to New Jersey. You can ask your employer to stop withholding Pennsylvania state taxes, and you would only need to file a New Jersey tax return. The reverse situation also applies: if you lived in Pennsylvania and worked in New Jersey, you would only file a Pennsylvania return due to the reciprocal agreement.

Employers play a crucial role in administering these agreements. Once an employee provides documentation of their reciprocal agreement status, employers adjust their tax withholding accordingly. This means they only withhold state and local taxes for the employee’s home state, simplifying payroll administration and reducing compliance complexity.

States with Reciprocal Agreements

Currently, there are reciprocal agreements in place across 16 states plus the District of Columbia. These states include Arizona, Illinois, Indiana, Iowa, Kentucky, Maryland, Michigan, Minnesota, Montana, New Jersey, North Dakota, Ohio, Pennsylvania, Virginia, West Virginia, Wisconsin, and Washington D.C.

The following table outlines the key reciprocal relationships among these states:

Types of Reciprocal Agreements

While the fundamental purpose of reciprocal agreements remains consistent, states use two different types of agreements to achieve tax exemption for cross-state workers:

Bilateral Agreements

Bilateral agreements are arrangements between two specific states where both have agreed to provide either tax exemptions or tax credits to residents of the other state. The majority of reciprocal agreements currently in effect are bilateral agreements, though the specific details and benefits vary based on the states involved. For example, Maryland and Pennsylvania have a bilateral reciprocal agreement, meaning both states recognize each other’s residents working across their border.

In bilateral agreements, state statutes may dictate which sources of income are subject to the agreement. Additionally, it could be left to the discretion of revenue officers to conform to the policy of the reciprocating state. Some states, like Montana, only enter reciprocal agreements with contiguous (bordering) states, as outlined in their state law.

Unilateral Agreements

Unilateral agreements represent a different approach to reciprocity. Three states—Indiana, Minnesota, and Wisconsin—have a standing offer for reciprocity with any state that provides similar tax treatment for their residents. These states automatically extend reciprocal tax benefits to residents of other states without requiring a formal bilateral agreement.

For example, under Indiana’s unilateral agreement, nonresidents of Indiana who earn income within the state are exempt from taxes imposed by Indiana if the state or territory they are a resident of has a reciprocal provision that exempts residents of Indiana from taxes when they earn income within that state. This means if Illinois wanted to enter into a reciprocity agreement with Indiana, Illinois would only need to adopt a law providing similar tax relief for Indiana residents working in Illinois as Indiana residents working in Illinois receive.

Exemption Forms Required

To claim tax-exempt status under a reciprocal agreement, employees typically need to complete and submit an exemption form to their work state. States with reciprocal agreements usually have a corresponding exemption form for employees to submit to request their tax-exempt status.

Common exemption forms include:

• Pennsylvania: Form REV-419 (Employee’s Nonwitholding Application Certificate)
• Illinois: Form IL-W-5-NR
• Maryland: Form MW-507
• Washington D.C.: Form D-4A
• Michigan: Employers may create a custom exemption form or use the line on MI-W4 for claiming exemption from withholding

Employees should clearly write “Reciprocal Agreement” and the state name on the appropriate line of these forms. Employers may need to keep these forms on file for tax compliance and audit purposes.

Benefits of Reciprocal Agreements

Reciprocal tax agreements provide significant benefits for both employees and employers:

Benefits for Employees

For employees, reciprocal agreements simplify tax filing by eliminating the need to file state income tax returns in multiple states. This reduces filing complexity and potential mistakes. Additionally, employees avoid the possibility of double taxation on the same income. Without reciprocal agreements, an employee might have to pay taxes to both their home and work states, potentially resulting in higher overall tax liability or requiring a refund claim if the two states have different income tax rates.

Benefits for Employers

For employers, reciprocal agreements streamline payroll tax administration. Employers only need to withhold state and local taxes for the employee’s home state rather than managing tax withholding for multiple states. This reduces payroll compliance complexity and the likelihood of errors. Additionally, employers are not required to navigate conflicting tax regulations between multiple states for a single employee.

When Reciprocal Agreements Don’t Apply

Not all cross-state employment situations involve reciprocal agreements. For employees working in states without a reciprocal agreement with their home state, the typical tax rule applies: employees must pay state income tax to the state where they work. They may also be required to file a non-resident tax return in their home state.

In these cases, employees might owe extra taxes or receive a refund depending on the tax rates and credits available in each state. For example, if State A has a higher income tax rate than State B, an employee might owe additional taxes to State A even after paying taxes to State B, or they might be eligible for a tax credit to avoid double taxation.

Frequently Asked Questions

Q: What happens if I move to a different state?

A: If you move to a different state for work, your reciprocal agreement status changes based on your new home state. If your new home state has a reciprocal agreement with your work state, you would be eligible for tax exemption in the work state. If not, you would need to file and pay taxes in the work state.

Q: Can I claim reciprocal agreement status retroactively?

A: This depends on your specific state’s rules. Generally, you should submit your exemption form as soon as possible. Some states may allow retroactive exemption claims, but you should contact your state’s tax authority or your employer’s payroll department to confirm.

Q: Do reciprocal agreements apply to federal taxes?

A: No, reciprocal agreements only apply to state income taxes. You must file federal income taxes based on your income regardless of where you live or work, and the IRS does not recognize state reciprocal agreements.

Q: What if my employer refuses to honor a reciprocal agreement?

A: If your employer refuses to honor a reciprocal agreement despite your submission of proper exemption documentation, you should contact your state’s tax authority or department of revenue. You may also want to consult with a tax professional or employment attorney about your options.

Q: Do reciprocal agreements apply to self-employed individuals?

A: Reciprocal agreements typically apply to employees with withholding arrangements. Self-employed individuals generally must pay state income taxes where they earn their income, though specific rules may vary by state.

Q: Are there any income limitations for reciprocal agreements?

A: Most reciprocal agreements do not have income limitations. However, some agreements may exclude certain types of income, such as self-employment income or commission-based income. Check the specific terms of your states’ agreement or contact your tax authority for clarification.

Q: How do I verify if two states have a reciprocal agreement?

A: You can verify reciprocal agreements by checking the tax authority websites of both your home state and work state. You can also consult payroll professionals, tax software providers, or contact your state’s department of revenue directly.

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Author

medha deb

 

Medha Deb is an editor with a master's degree in Applied Linguistics from the University of Hyderabad. She believes that her qualification has helped her develop a deep understanding of language and its application in various contexts.

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